If you’re evaluating active Canadian equity funds, pay special attention to their current exposure to energy and materials stocks. It might help explain their performance.
Morningstar’s new Canadian Conundrum report, available here, evaluates the historical return of actively managed Canadian equity funds since the category’s last rework in June 2007. Its findings were twofold: The Canadian stock market is tough to beat even before fees are considered, and most active strategies held persistent tilts away from commodity sectors (energy and materials) toward consumer sectors (discretionary and staples). Such tilts could explain fluctuating short-term success for active management.
It’s Tough to Beat an Index
On a 10-year rolling basis, most Canadian equity funds failed to beat the Morningstar Canada Index before fees. Even a 1% fee cut the chances of outperformance in half. Nearly a third of Canadian equity strategies beat the index before fees over the last 10 years ending September 2024. About a sixth did if assuming a 1% fee.
Temporary Success for Active Management
There was a time when as many as three in five funds could say they beat their index over the trailing three-year period. Such success wasn’t ever seen in global equity; it seemed uniquely Canadian.
Portfolio composition may explain the swings. From June 2007 to September 2024, the excess returns of the median Canadian equity fund were higher when consumer staples and discretionary did well and worse when materials stocks did well. Sector positioning over the period also matches these return profiles—most funds were underweight materials and overweight consumers.
The report analyzes and estimates the impact of positioning in seven of the 11 sectors. Some of the greatest effects were seen in the commodity sectors. Most funds largely benefited from underweighting energy and materials throughout the 2010s as they underperformed. That flipped by the end of 2020, with energy stocks strongly rebounding.
Know What You Own
It’s important to know what your fund holds when setting your expectations. Many Canadian equity funds are still underweight in commodity sectors and overweight in consumer sectors. Consider whether the manager has a more flexible and nuanced approach to tackle these sectors. A constant lack of commodity exposure can overshadow even a great Canadian stock picker.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
